Company Perspectives:

To be a leading low-cost producer of gas and oil in the United States, so as to realize an attractive return on invested capital in any pricing environment.

Company History:

Belco Oil & Gas Corp. is an independent energy company that since its creation in 1992 has been primarily engaged in the exploration of natural gas and oil in the United States. Using state-of-the-art technology, Belco has been particularly successful at extracting oil in areas once considered unprofitable. The company, headquartered in midtown Manhattan, focuses its operations in four major geological regions: the Rocky Mountains, in particular the Green River Basin of Wyoming; the Permain Basin of West Texas; the Mid-Continent region in Oklahoma, north Texas, and southwest Kansas; and the Austin Chalk Trend in Texas as well as the formation's extension into Louisiana. Involved in oil exploration since the mid-1950s, Robert A. Belfer returned to the business with his son Laurence by starting up Belco, then taking the company public in 1996. The Belfer family maintains a controlling interest in Belco stock, which is traded on the New York Stock Exchange. Although committed primarily to growth through its drilling program, Belco also pursues a strategy of selective acquisition.

Birth of Two Family Businesses: 1950s-90s

Robert Belfer was born in Poland in 1935. When Germany invaded the country, he and his immediate family fled, making their way to the United States in 1942. Belfer graduated from Columbia College in 1955 with an engineering degree, then earned a law degree from Harvard University. His father, Arthur Belfer, established Belco Petroleum Corporation in 1954. After a few years of exploring for oil on his own, Belfer joined Belco Petroleum in 1958. In 1965 he became president of the company, which had become one of the largest independent oil and gas companies in the United States, listed among the Fortune 500. In 1983 it merged with InterNorth, Inc., and Belfer became chief operating officer of the resulting BelNorth Petroleum Corp. In 1985 BelNorth merged with Houston Natural Gas and changed its name to Enron Corp. A year later Belfer, unwilling to move to the new Houston headquarters, resigned to pursue other business interests, although he remained a major stockholder in Enron and a board member.

Laurence Belfer graduated from Harvard University in 1988, then earned a degree from Columbia Law School. In a 1998 interview for Oil & Gas Investor, Robert Belfer recalled, 'When my son finished law school, he had heard about all of the good times we had in the oil and gas patch and thought it would be nice to start another company; so we did in 1992. We went back to Wyoming where the old Belco had its roots, and started a successful drilling program along the Moxa Arch.' Also joining them were several employees from the old Belfer Petroleum Corporation.

Although Belfer was only several years removed from the business of oil and gas exploration, the technologies for locating and drilling for resources, enhanced greatly by new computer capabilities, were in the process of dramatic change. Most of the elements had been around for decades, after the science of petroleum exploration expanded beyond the primitive methods of the 19th century that consisted of looking for surface oil seepages, or perhaps the use of a divining rod, then digging a hole with a pick and shovel. Cable-tool drills were developed to bore through hard rock formations, followed by faster rotary drills. In the 1930s horizontal drilling was developed to augment strictly vertical shafts, and seismic imaging was first used as a way to detect oil-bearing formations below the earth's surface. The oil industry was also an early advocate of computer technology. In fact, today's Texas Instruments was originally Geophysical Service, created in 1930 to work with seismographic data for the oil industry. For decades, computers were only robust enough to provide crude two-dimensional pictures of geological formations. By 1975 three-dimensional seismic imaging came into commercial use, but it was too expensive and too slow. The method continued to evolve, however. In 1985 to process a square kilometer's worth of data required 800 minutes. Ten years later it would take only ten minutes. A 50-square-mile survey that cost $8 million in 1980 would cost $1 million in 1990 and less than $100,000 ten years later.

It was advances in horizontal drilling that had a major effect on Belco in its early years. From a single vertical shaft, new horizontal drilling capabilities allowed companies to create a network of shafts reaching out in all directions. This technique was particularly useful in certain geological conditions, such as those found in a limestone formation called the Austin Chalk Trend that cuts across southern Texas into Louisiana. Technological advances in the 1930s had led to the first cycle of extraction of oil in the region. When oil prices rose in the 1970s the area was again drilled, almost recklessly, only to be virtually abandoned when prices fell. The Austin Chalk was a difficult region to understand. A well would deliver generous amounts of oil then suddenly lose pressure and drop to a trickle. It rightly earned the nickname of 'Heartbreak Field.' Belfer called it a graveyard when Belco began working the area.

Using 3-D seismic imaging, engineers discovered that oil deposits in the Austin Chalk were to be found in thin horizontal strata, permeated with vertical cracks within which the oil pooled from the surrounding impermeable rock. If a vertical well intersected a crack it would strike oil, which would then be quickly drained. In the early 1990s, energy companies like Belco learned to drill a horizontal shaft that would intersect with a number of vertical cracks filled with oil, drawing several times the amount of oil that vertical shaft wells could produce in the area. Furthermore, energy companies could then repeat the process by drilling lower, reaching into another oil-bearing strata to drill another horizontal shaft to link up more vertical cracks containing oil. By employing this method companies now drew four times the amount of oil from the Austin Chalk than the region's previous peak.

Going Public: 1996

Belco's business thrived in the Austin Chalk. According to Belfer, 'We recognized that we had a rather sizable company on our hands and decided to go public in March of 1996 with Goldman Sachs and Smith Barney as our managers.' The sale of 6.5 million shares of common stock resulted in net proceeds of $113 million after expenses. The company's stated intention was to continue to pursue a core area concept, focusing on the Giddings Field of east central Texas, the Moxa Arch Trend of southwest Wyoming, and to a smaller extent the Golden Trend of southern Oklahoma. The core concept allowed Belco to achieve economies of scale with vendors, and it helped to keep down overhead. Furthermore, when the company discovered a new procedure that was successful with one well, it had other similar locations in which to apply it. The overall plan in 1996 was to continue to grow 'through the drill bit' rather than acquisitions. Belco looked to keep costs down and manage the risk of price swings in oil and gas through a hedging program.

Belco's first year as a publicly traded company was successful on a number of levels. Revenues reached $116.4 million, an increase over the previous year of 48 percent. Operating profit and net income also showed healthy gains. Average daily production of natural gas was up 31 percent, and the company's reserves of natural gas increased 39 percent. During the course of the year, Belco began new drilling operations in Texas, Louisiana, and Michigan. It continued to apply the latest technology available. Belco participated in drilling the world's then deepest horizontal well. The company also teamed with Edge Petroleum Corporation to commission a 3-D seismic shoot of a 750-square-mile region of Texas; after interpreting the data, point targets could be identified and drilling could commence. Belco also prepared itself for future growth by hiring additional technical and nontechnical personnel, and by spending more than $60 million to add 868,000 net undeveloped acres of land in Louisiana, Michigan, Texas, and Wyoming. The company looked to build on its existing core areas, in particular the Austin Chalk Trend extension into Louisiana, as well as a possible new core area in the Central Basin of Michigan.

Belco went into 1997 looking to stay the course, but instead underwent some significant changes. For one, the prices of oil and natural gas went through a year of volatility that proved challenging for Belco and the industry as a whole. More importantly, in the first part of 1997 the company was unable to match the growth it had achieved in previous years. Many of its newer projects were still in the developmental stage, and the Austin Chalk now required deeper, more expensive wells that were also taking longer to begin producing. Thus, Belco decided to modify its growth strategy. In November 1997 it acquired Coda Energy, Inc. for $149 million in stock and the assumption of $175 million of debt.

Coda was a good fit for Belco on a number of levels. Coda added to the company's reserves of both oil and gas, and provided a better balance between the two commodities. Reserve life increased from 5.3 years to approximately nine years, and the reserve mix now stood at 51 percent oil and 49 percent natural gas. Coda's property also complemented Belco's core holdings, allowing the company to continue to exploit its economies of scale in these areas. Furthermore, Coda brought with it an organization and expertise in acquisition that could then be utilized for future transactions.

Because of the Coda acquisition, Belco incurred tax liabilities that resulted in an after-tax loss of $56.9 million in 1997. Nevertheless, underlying factors remained healthy for the company. Revenues increased by 9 percent to $126.8 million; and earnings before the costs of the Coda transaction were up 4.4 percent to $110.1 million. Overall, the benefits of the deal greatly outweighed the short-term hit.

1992:Company is started by Robert Belfer and son Laurence.

1996:Belco goes public.

1997:Company acquires Coda Energy.

Drilling Cutbacks Due to Dropping Oil Prices: 1998

The economics of drilling in 1998 would be complicated by a fall in oil prices, which caused Belco to cut back on drilling as the year progressed. Belco would be significantly insulated from lower prices, however, because of its hedging program that placed contracts in the futures market and provided it with a more secure cash flow stream than other oil and gas companies. Coupled with low interest rates, the difficult financial environment of the industry actually presented Belco with opportunities to purchase the assets of weaker companies. After reviewing some $4 billion of potential acquisitions, the company would spend $53 million on new land.

On the surface, 1998 was an unsuccessful year for Belco. It reported a loss of $225.7 million before income tax benefits, but this result was mostly due to accounting requirements. Nevertheless, average daily production was up; Belco's reserve life increased to ten years; and pretax profitability stood at $47.3 million. The former Coda organization was moved from Houston and incorporated into the Dallas office. Building for the future, Belco generated and supervised a 145-square-mile 3-D seismic shoot in Texas, the results of which promised to provide the company with a significant number of targets for drilling. Furthermore, Belco employed advanced technology in other parts of its core region. In the Rocky Mountains it used innovative fracturing techniques to shatter rocks at the bottom of wells. In parts of Texas and Oklahoma it operated sophisticated enhanced recovery projects, flooding wells with water to force more oil to the surface. Less successful for Belco in 1998, however, were its investments in other companies. The company liquidated its position in Hugoton Energy. A major purchase of stock in Canada-based Big Bear Exploration also proved disappointing, but Belco remained hopeful about its future prospects.

Market conditions continued to be difficult in 1999 but improved through the course of the year. Belco remained a viable independent company, although it continued to labor through a transition from energetic small upstart to a steady mid-size company. Oil and gas revenues increased 12 percent to $139.2 million and Belco's reserve life stood at 10.6 years. Concentrating on gas projects, Belco spent $57 million on drilling-related expenditures, and its operating costs remained among the lowest in the industry. Although the company spent $18 million acquiring new assets, it was not able to strike as many deals with cash-strapped companies as it had hoped. Nevertheless, Belco retained $108 million of a $150 million credit line and looked to continue its strategy of selective acquisitions.

Belco entered the new century with some financial issues to resolve. In December 2000 it canceled a public offering of four million additional shares of stock, the proceeds of which it had planned to use to pay down debt and attract new institutional investors. The company blamed the cancellation on poor market conditions. The potential for Belco, however, remained strong. It boasted seasoned leadership and a firm grasp of the latest technology that continued to change the nature of the oil and gas business. Although the United States remained the most mature hydrocarbon region of the world, it had added impressively to its reserves, almost 90 percent of which came from old fields. There appeared to be a significant amount of U.S. resources yet to be extracted by savvy companies such as Belco.